We have covered the euro bearish fundamentals in our last article so here we will focus on the Yen’s which we believe will soon cause a major yen rally against all other major currencies.
Bank of Japan Policy Change Coming
The biggest piece of news in FX markets last week which was mostly ignored by the media was a shift in tone by the Bank of Japan which could point to the end of their ultra-dovish policy.
Yield Control and Negative Rates to End
Governor Kuroda said his central bank could make its yield curve control strategy “more flexible” in the future which points to a normalization of monetary policy.
The Bank of Japan has been involved in yield curve control which essentially caps longer-dated Japanese rates. Since Japanese yields are not allowed to rise beyond a certain level, interest rate differentials widen against the yen as foreign central banks raise rates.
Bank of Japan Intervention
The Yens downside is limited by the threat of intervention by the Bank of Japan
While the Bank of Japan has intervened in the market to buy Yen this policy is not effective longer term so a change of policy is likely
Nordea make the following point: “Countries do not have an endless amount of USD at disposal to sell, meaning that the FX intervention will fail when their USD coffers run dry. Moreover, FX intervention involves the selling of US Treasuries, which adds upwards pressure on US rates and leads to a stronger USD in isolation. This FX intervention USD doom-loop (illustrated below from the perspective of Japan) could lead to dollar overshooting – especially when several central banks are enforcing the loop." (NORDEA)
The chart below is USD/JPY but the same happened in EUR/JPY after a small pullback the Yen weakened.
There is now a lot of discontent from both businesses and consumers about the impact of a weak yen and with elections coming up pressure will mount on the BoJ to normalize policy. Also, Inflation is now on the rise which will add to the pressure to normalize policy.
The annual inflation rate in Japan stood at 3.0% in September 2022, the same as August's reading near an 8-year high figure, due to high prices of food and raw materials as well as yen weakness.
In our previous article on EUR/USD, we noted that speculators are heavily bullish on the euro and we also have them holding a large long position in EUR/JPY. On our COT data analysis, we are at over a year high in terms of long positions and we expect these longs to get hit on stop and trigger a major downside correction.